Essays on Stock Liquidity

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Date

2017-07-11

Author

Haykir, Ozkan

Date issued

2017-07-11

Type

Thesis or dissertation

Language

en

Publisher

University of Exeter

Abstract

This thesis consists of three main empirical chapters on the effect of stock liquidity on exchange markets. The first (Chapter 2) investigates the pricing ability of an illiquidity measure, namely the Amihud measure (Amihud, 2002), in different
sample periods. The second (Chapter 3) determines the causal link between two well-known market quality factors liquidity and idiosyncratic volatility adopting two-stage least squares methodology (2SLS). The last empirical chapter (Chapter
4) revisits the limits to arbitrage theory and studies the link between stock liquidity and momentum anomaly profit, employing the difference-in-differences approach. The overall contribution of this thesis is to employ causal techniques in the context of asset pricing in order to eliminate potential endogeneity problems while investigating the relation between stock liquidity and exchange markets.
Chapter 2 investigates whether the Amihud measure is priced differently if the investor is optimistic or, conversely, pessimistic about the future of the stock markets.The results of the chapter show that Amihud measure is priced in the low-sentiment period and that there is illiquidity premium when investor sentiment is low.
Chapter 3 studies whether a change in stock liquidity has an impact on idiosyncratic volatility, employing causal techniques. Prior studies investigate the link between liquidity and idiosyncratic volatility but none focus on the potential problem of
reverse causality. To overcome this reverse causality problem, I use the exogenous event of decimalisation as an instrumental variable and employ two-stage least squares approach to identify the impact of liquidity on idiosyncratic volatility. The results of the chapter suggest that an increase in illiquidity causes an increase in idiosyncratic volatility. As an additional result, my study shows that reduction in the tick size as a result of decimalisation improves firm-level stock liquidity.
Chapter 4 examines whether liquid stocks earn more momentum anomaly profits compare to illiquid stocks, using the implementation of different tick sizes for different price ranges in the American Stock Exchange (AMEX) between February
1995 and April 1997. This programme provides a plausibly exogenous variation to disentangle the endogeneity issue and allows me to examine the impact of liquidity on momentum, by clearly exploiting the difference-in-difference framework. The
results of the chapter show that liquid stocks earn more momentum profit than illiquid stocks.